When should you rebalance your investments?
Given how volatile 2020 has been, you may have read sources reminding you the best defense against market uncertainty is to stay the course by rebalancing your investments back to plan. That’s good advice. But what is rebalancing? And how do you know when it’s time to do it?
Rebalancing means selling overweighted positions and buying underweighted ones. For example, say you decide to hold 60% stocks/40% bonds in your portfolio. But over time, stock values rise relative to bonds, until your allocation becomes 72% stocks/28% bonds. To rebalance, you sell some stocks, and use the money to buy more bonds, until you’re back to your 60/40 split.
Ideally you rebalance across broad asset classes (stocks, bonds, cash, and real estate) and the sub-classes for each (such as large U.S. company versus small international stocks, Treasuries versus corporate bonds, etc.).
How often do you rebalance? Because rebalancing can incur taxes and trading costs, the expected benefits should first outweigh the costs. We’ve seen two ways to pace yourself accordingly:
Periodic rebalancing is easier to implement, but more arbitrary. Basically, you rebalance all positions back to their targets according to a set schedule, such as annually or quarterly.
Strategic rebalancing is more deliberate, but more complicated. You continually monitor your portfolio, but only rebalance when a position drifts too far off-target. For example, say you allocate 10% to U.S. large-cap growth stocks – give or take a “band” of 20%. In this case, that’s 8%–12%. As long as your ideal allocation remains within this band, you leave it be. If it drifts above or below it, you rebalance.
There is one more way: Do you have new cash to invest? Use it to buy underweight (cheap) positions and bring them up to your target. Are you taking cash out? Take it from overweight (expensive) positions to bring them down. Other than that, I recommend strategic over periodic rebalancing. Because markets typically rise over time, strategic rebalancing increases the odds you’ll be buying low and selling high. Also, costs should be lower, because you’re only rebalancing the investments that are significantly off-target.
So, that’s the quick take on using strategic rebalancing to buy low, sell high, and manage costs through volatile markets. It’s hard to argue with a strategy designed to bring you all that.
John A. Frisch, CPA/PFS, CFP®, AIF®, PPC™ founded Alliant Wealth Advisors in 1995 and has over 30 years of experience as a financial professional. In his free time, he’s an avid long-distance runner, a sport that requires discipline, patience and vision. John applies these same skills to his professional pursuits: He helps families and retirement plan sponsors adopt a patient, disciplined approach to overcoming financial challenges and reaching their distant goals along a clear path. Learn more at www.alliantwealth.com.